Concepts Worth Knowing - Gross Investment And Depreciation

Investments in the vast majority of cases are implemented through the purchase of services and goods by enterprises. Of course, they will be implemented much less often by state institutions or households.

Gross investment

Gross investment - includes the production of new capital goods and the improvement of existing capital goods, e.g. construction of roads, bridges, buildings and structures, purchase of machinery, technical equipment and tools, means of transport, purchase of product manufacturing licenses. Investments are most often implemented through the purchase of goods and services by enterprises. Less often, however, they are implemented by households and state institutions.

The ratio of depreciation to gross investment shows whether a given country has carried out investments at a level allowing for the replacement of the used part of the assets.

Gross investments vs. net investments

Gross Investments = Net Investments + Depreciation

The term of gross investments is closely related to net investments, which are gross investments less the depreciation value of the existing capital stock. Depreciation is an economic reflection of the process of using up the existing stock of fixed capital, more precisely - it reflects the equivalent of using up the capital stock in a given period. The consumption of the stock of physical capital means that some of the goods produced in the economy (i.e. capital goods) should be used to replace the used capital. To sum up - a part of the total investments (ie gross investments) must be allocated to the replacement of the used capital stock in sizes corresponding to depreciation. The remainder of the investment (i.e. net investment) can be used to augment the existing capital stock.

Gross investment and measures of production

Gross Domestic Product and Gross National Product are measures of production that include gross investment. Due to the difficulties in estimating depreciation on a macroeconomic scale, GNP and GDP are more often used in economic analyses, despite the fact that Net National Product (national income) better reflects the income generated in the economy.

Depreciation

The term depreciation refers to an accounting method used to allocate the cost of a tangible or physical asset over its useful life. Depreciation represents how much of an asset's value has been used. It allows companies to earn revenue from the assets they own by paying for them over a certain period of time.

Assets such as machinery and equipment are expensive. Instead of realizing the entire cost of an asset in year one, companies can use depreciation to spread out the cost and match depreciation expenses to related revenues in the same reporting period. This allows a company to write off an asset's value over a period of time, notably its useful life.

Companies take depreciation regularly so they can move their assets' costs from their balance sheets to their income statements.

There are many types of depreciation, including straight-line and various forms of accelerated depreciation.

Using the straight-line method is the most basic way to record depreciation. It reports an equal depreciation expense each year throughout the entire useful life of the asset until the entire asset is depreciated to its salvage value.

The declining balance method is an accelerated depreciation method. This method depreciates the machine at its straight-line depreciation percentage times its remaining depreciable amount each year. Because an asset's carrying value is higher in earlier years, the same percentage causes a larger depreciation expense amount in earlier years, declining each year.

The double-declining balance (DDB) method is another accelerated depreciation method. After taking the reciprocal of the useful life of the asset and doubling it, this rate is applied to the depreciable base—its book value—for the remainder of the asset’s expected life. Thus, it is essentially twice as fast as the declining balance method.

Source: Begg B., (2007) Macroeconomy